Mutual Fund Prospectus Will Provide Useful Data

Mutual Fund Prospectus Tells A Lot

You've decided to put your money in a mutual fund, and you're considering a handful of them. How do you decide which one to invest in?

You could seek advice from an investment professional, read periodicals or scan sales literature.

But one of the best ways of finding out about the beauty -- and the warts -- of a mutual fund is in its prospectus.

A prospectus is a legally required document that explains everything you need to know about a mutual fund -- especially the risk involved.

Some investors may shun the dry and legalistic prospectus in favor of a slick sales brochure, but the prospectus contains information that a salesman would shudder to put in glossy folders.

It will give you an indication of the number of times the fund manager sells off stocks or bonds -- a key indicator of how much the fund pays in transaction fees.

It will tell you where the fund invests its assets, from the safety of government securities to the volatility of penny stocks.

It will tell you about the fund's past performance (although it will be careful to point out that the past is no guarantee of the future).

"In every prospectus, it should say what they plan to do with the fund, which is their investment objective," said Michael Corbett, an analyst for The Mutual Fund Letter, a Chicago-based trade publication.

One of the most important sections of a mutual fund prospectus details its strategy -- how the manager plans to achieve the fund's objective. This section could reveal a number of hidden risks.

The strategy might involve investing in U.S. government bonds, small company stocks or the stock of large established companies. But it could also include investing a percentage of the fund's assets into more risky investments. For instance, while the Securities and Exchange Commission requires that a U.S. government bond fund invest at least 65 percent of its assets in safe Treasury bonds and the bonds of other U.S. agencies, an obvious question is how the fund plans to invest the other 35 percent. This can also be

found in the prospectus.

Many of these funds invest 100 percent of their assets in U.S. government bonds.

But some of these conservative funds invest a portion of their assets in low-rated, risky corporate bonds in an effort to get a higher overall return..

"Some of the funds use options or futures to hedge the portfolio," said Peter Miller, manager of A.G. Edwards & Sons Inc.'s Farmington office. "They have to disclose it in the prospectus."

Here are some of the other things to look for in a mutual fund prospectus:

Investment objectives:

"Reviewing the fund's objectives ... will help you determine if the fund meets your own goals," said Patricia Nickols, portfolio manager for Advest Inc. in Hartford, a brokerage firm. The objective might be generating income, preserving principal or longterm growth.

Portfolio turnover rate:

Turnover rate, or the rate at which the fund manager sells off stocks, is a key indicator of risk, Corbett said.

"A high turnover rate might translate into higher transaction fees, which could eat away at the fund's return," Corbett said. It could also mean the stocks purchased by the fund are decreasing in value, and as a result, being sold off.

A mutual fund with a turnover rate of 250 to 300 percent is very high and indicates a lot of selling and risk, he said.

"You could see funds that buy something one week and sell it the next week," Corbett said. "Typically, what we look for is [a turnover rate of] at least under 100 percent per year."

Risk:

"Since all investments involve a degree of risk ranging from minimal to substantial, many prospectuses have a section on risk," Nickols said. "It describes the risks associated with a particular type of fund or security."

Historically, investing in stocks is more risky than bonds, but also provides a better return.

If the prospectus does not answer all of your questions, there are other sources to check out.

Nickols suggests that investor seeking more details should request the fund's "Statement of Additional Information."

"It includes such items as the fund's audited financial statements, a list of directors and officers of the fund and anyone who owns 5 percent or more of the fund's shares," Nickols said. This will give you an idea of what large institutional investors, such as banks, insurance companies and pension funds have invested in the mutual fund.

Beyond the prospectus, of course, there are other sources of information about mutual fund performance. Research firms and trade publications that specialize in this area include: Lipper Analytical Services Inc. in Summit, N.J., which reports on fund yields over one, five and 10-year periods; Morningstar, a Chicago-based newsletter; and The Mutual Fund Letter, a trade publication.

Doing your homework will help you narrow the field and choose the best fund to match your financial objectives and tolerance for risk.

There are more than 3,400 mutual funds and more than 20 different investment categories to choose from, according to the Investment Company Institute's 1992 Directory of Mutual Funds. And in each investment category, there can be as many as 200 to 300 different funds